Monetary Policy Implications of State-Dependent Prices and Wages

63 Pages Posted: 7 Jan 2019

See all articles by James Costain

James Costain

European Central Bank (ECB)

Anton Nakov

European Central Bank (ECB); CEPR

Borja Petit

CUNEF Universidad, Department of Economics

Multiple version iconThere are 3 versions of this paper

Date Written: December 2018

Abstract

This paper studies the dynamic general equilibrium effects of monetary shocks in a "control cost" model of state-dependent retail price adjustment and state-dependent wage adjustment. Suppliers of retail goods and of labor are both monopolistic competitors that face idiosyncratic productivity shocks and nominal rigidities. Stickiness arises because precise choice is costly: decision-makers tolerate errors both in the timing of adjustments, and in the new level at which the price or wage is set, because making these choices with perfect precision would be excessively costly.

The model is calibrated to microdata on the size and frequency of price and wage changes. We find that the impact multiplier of a money growth shock on consumption and labor in our calibrated state-dependent model is similar to that in a Calvo model with the same adjustment frequencies, though the response is less persistent than it would be under the Calvo mechanism. Wage rigidity accounts for most of the nonneutrality that occurs in a model where both prices and wages are sticky; hence, a model with both rigidities produces substantially larger real effects of monetary shocks than does a model with sticky prices only. We find that the state-dependence of nominal rigidity strongly decreases the slope of the Phillips curve as trend inflation declines. This result is not driven by downward wage rigidity; adjustment costs are symmetric in our model. Here, instead, price- and wage-setters prefer to adjust less frequently when trend inflation is low, making short-run inflation less reactive to shocks.

Keywords: control costs, logit equilibrium, near rationality, state-dependent adjustment, sticky prices, sticky wages

JEL Classification: C73, D81, E31

Suggested Citation

Costain, James and Nakov, Anton A. and Petit, Borja, Monetary Policy Implications of State-Dependent Prices and Wages (December 2018). CEPR Discussion Paper No. DP13398, Available at SSRN: https://ssrn.com/abstract=3310292

James Costain (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Anton A. Nakov

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

CEPR ( email )

London
United Kingdom

Borja Petit

CUNEF Universidad, Department of Economics ( email )

Calle de los Pirineos 55
Madrid, 28040
Spain

HOME PAGE: http://https://borjapetit.github.io/

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